1. CHAPTER 9 Investment Management: Concepts and Strategies Chapter 9: Investment Concepts 1

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3. FIXED INCOME SECURITIES  FIXED-INCOME SECURITY RETURN  FIXED-INCOME SECURITY RISK  Interest Rate Risk  Inflation Risk  Maturity Risk  Default Risk  Callability Risk  Liquidity Risk Chapter 9: Investment Concepts 3

4. RISK REDUCTION STRATEGIES  Ladder Bond Investments  Invest in Tax-exempt Bonds  Diversify with Intl. Bonds  Adopt Dollar Cost Averaging Strategy Chapter 9: Investment Concepts 4

5. Buying and Selling Bonds  Buying Bonds  Bond Yield  Bond Ratings  Current Yield vs. Yield to Maturity  Selling Bonds  Underperformance  Change in Company Position  Extent of Loss  Tax Consequences Chapter 9: Investment Concepts 5

6. Investors’ Services Rating Classification Chapter 9: Investment Concepts 6

7. EQUITY RETURN AND RISK  EQUITY RETURN  Over time, return based on increase in sale price plus dividend payments  Should outpace inflation  EQUITY RISK  Beta – market risk  Alpha – estimated return if mkt = 0  Standard Deviation  Greater dispersion greater risk  Sharpe Ratio  Risk adjusted return  Morningstar Risk-adjusted Rating Chapter 9: Investment Concepts 7

8. TRADING IN EQUITIES  Buying Stocks  Fundamentally Strong  Selling Below Present or Intrinsic Value  Selling Stocks  Theory of Undervalued Security  Realization of Goals  Change of Conditions Chapter 9: Investment Concepts 8

9. LIMITING EQUITY RISK  Dollar Cost Averaging  Constant Ratio Plan  Variable Installment Plan  Strategy of Covered Calls  Chapter 9: Investment Concepts 9

10. Market Volatility and Dollar Cost Averaging Chapter 9: Investment Concepts 10

11. SALE OF MUTUAL FUNDS  Basic Issue  Change of Investment Objective  Consistently Poor Performance  Fund Size  Miscellaneous Changes Chapter 9: Investment Concepts 11

12. MUTUAL FUNDS AND TAXES  Fund Distributions  Calculation of Capital Gains or Losses on Fund Sales  Specific Identification Method  First-in, First-out Method  Average Cost Method Chapter 9: Investment Concepts 12

13. THEORY OF PORTFOLIO CONSTRUCTION Most effective strategies are based on:  Diversification  Asset Allocation Chapter 9: Investment Concepts 13

14. THEORY OF EFFICIENT PORTFOLIO  Expected return of a portfolio is weighted average of individual assets in the portfolio  If assets are not perfectly correlated, risk of the portfolio will be less than the weighted average of the risks of individual assets in the portfolio  By diversifying a portfolio with assets that are not perfectly correlated, investor can reduce overall risk of the portfolio without sacrificing the average return  This is the essence of modern portfolio theory Chapter 9: Investment Concepts 14

15. CAPITAL ASSET PRICING MODEL  Investor expecting to beat the market without assuming additional risk must generate a rate of return that exceeds return of this portfolio  If investor assumes higher level of risk than the risk of this efficient portfolio, then a higher level of return must be realized to compensate for the additional risk assumed  If the return of a portfolio with similar risk is less than the expected return of the efficient portfolio, then the investor failed to construct an efficient portfolio Chapter 9: Investment Concepts 15

16. POWER OF DIVERSIFICATION  Domestic Diversification  Global Diversification Chapter 9: Investment Concepts 16

17. EFFICIENT FRONTIER  All portfolios below the efficient frontier curve are inefficient portfolios. As compared to portfolios on the frontier, they either offer lower returns or assume higher risks  All portfolios on the efficient frontier curve are efficient. Each portfolio offers the highest expected return for the risk class Chapter 9: Investment Concepts 17

18. ASSET ALLOCATION MODEL (AAM)  Investors diversify holdings by spreading assets among companies, industries and countries  Investors should also diversify across a minimum of three asset classes: stocks, bonds, and money market securities Chapter 9: Investment Concepts 18

19. ASSET ALLOCATION MODEL (Contd.)  Risk and reward are positively related  Investors should hold a portfolio that is diversified among three asset classes and has investor’s desired level of risk Chapter 9: Investment Concepts 19

20. PORFOLIOS OF U.S. STOCKS AND BONDS Chapter 9: Investment Concepts 20

21. ASSET ALLOCATION STEPS 1. Determine type of portfolio that matches investor’s risk tolerance 2. Analyze prevailing market and financial conditions 3. Select different types of investment products in each asset class 4. Select mutual funds and individual securities that match selections made in Step 3 Chapter 9: Investment Concepts 21

22. Rebalancing a Portfolio  Rebalancing is not a market timing strategy  It is a systematic approach to maintaining a consistent risk profile Chapter 9: Investment Concepts 22

23. How can you determine which mutual fund is the best to buy? 1. First we need to select a fund family. The service of switching funds and the break points for obtaining lower investment costs makes the use of one fund family the best option. 1. Many larger fund families have many mutual funds 2. Each fund family will have good and bad funds. 3. The greater the number to choose from the less likely you would be “forced “ to invest in a poor performer. 4. In a 401K this strategy is not important. You will have a mix of fund families. Switching and break points are not important.  This is not scientific, but does start by identifying those characteristics that are important for return generation Chapter 9: Investment Concepts 23

24. 2. Classify the mutual family’s funds by basic categories 1. Aggressive growth 2. Growth 3. Growth and income 4. Income 5. Sector 6. Time targeted 3. Gather the information you deem important for fund performance for each fund in each group. 1. I would first filter the group by life as a fund. 2. Eliminate all funds with an inception date sooner than 3 years. 4. Create a checklist to rank the funds. Chapter 9: Investment Concepts 24

25. Chapter 9: Investment Concepts 25